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For Every Gizmo, A TI Chip

August 15, 2004

It couldn't have been the coming-out party that Richard K. "Rich" Templeton wanted. On July 20, the 45-year-old chief executive of Texas Instruments Inc. (TXN) presided over his first quarterly earnings report since taking over in May. Sales at the semiconductor giant surged 39%, to a record $3.2 billion, for the second quarter, while net income more than tripled, to $441 million. "It really represents how strong the markets are that we serve," Templeton said. Yet the next day, TI's shares sank 5%, to $20.61. The culprit: a slowdown in TI's orders late in the quarter and a rise in inventories. "That was enough to basically tell investors: 'Run for the hills,"' says American Technology Research Inc. analyst Erach Desai.

Templeton is taking the helm of the world's No. 3 chipmaker in treacherous times. Skittish investors are scattering at any sign from the semiconductor industry that the young recovery in tech spending is sputtering. And there have been a few of them recently: flattening profit margins at Intel (INTC), glitches at one state-of-the-art IBM (IBM) factory, and TI's revelation of a slowdown in demand. Meantime, TI is in the crosshairs of powerful rivals -- Qualcomm (QCOM) in particular -- which are redoubling their efforts to unseat the Dallas company as the top provider of chips for mobile phones and other wireless devices.

Templeton's battle plan could be called Convergence Inc. He's betting that TI can be the premier arms dealer in the war to supply consumers with a new generation of gadgets. Not only does TI have the experience and leadership in mobile phones, but it also has the engineering talent to supply the innards for digital cameras, broadband modems, and the new wireless technology known as Wi-Fi. Put them all together, and TI can help Nokia (NOK), Motorola (MOT), Hewlett-Packard (HPQ), and others develop entirely new devices for Digital Age consumers. Already, TI and its partners are working on mobile phones with high-resolution cameras, handheld computers that can make voice calls over the Internet -- even phones that can download a John Coltrane tune over a wireless Net link and then play it while on the run. "We see a world where every phone call is made across a TI [chip], every picture is captured with a TI [chip]," says Templeton. "If you weren't working on this 10 years ago, you're coming from way behind."

That strategy should keep TI solidly on track -- provided the semiconductor industry doesn't crack. The company will benefit from strong mobile-phone sales, expected to rise 20% this year, to 625 million phones, according to researcher iSuppli Corp. TI gets an added benefit as those phones take on new capabilities: It can sell one chip to process voice calls and another to handle camera functions or other tasks. That means TI can pull in two to three times as much revenue from new, sophisticated phones as it did from the voice-only phones of the past. TI's revenues are expected to rise 32% this year, to $13.0 billion, as net income soars 53%, to $1.8 billion, according to research firm Legg Mason Inc. (LM) "They're in a great position," says analyst David Lytel of independent research firm Precursor.

The change at the top has been a subtle one, befitting the 74-year-old company's quiet, conservative style. Like the last CEO, Thomas J. Engibous, Templeton has spent his entire career at TI. He joined in 1980 after graduating from Union College in Schenectady, N.Y., about 100 miles north of his childhood home in a suburb of Poughkeepsie. In 1996, Engibous tapped the tall, hard-charging salesman to help focus TI on digital signal processors, the brains of cell phones, as the company shed businesses that made everything from computer memory chips to complete laser-guided missiles. The restructuring worked, and profits soared. In 2000, Templeton was named chief operating officer -- just before the chip sector sank into its worst slump ever. He quickly navigated TI through the storm by cutting jobs and capacity. "He was very hawkish [about costs]," says Bill Eversole, a former TI exec who is now CEO of Bandspeed Inc., an Austin (Tex.) wireless startup.

Templeton made sure TI came out of the downturn swinging. He doubled the amount of time he spent with customers, traveling as far as Korea to listen to their concerns. And he sent 2,000 employees through a two-day boot camp designed to help them better understand customer gripes. Employees played the role of phonemakers, agreed to certain launch dates, and then were told that TI couldn't have the chips ready on time. "We wanted them to really feel the customers' pain," says Jeff McCreary, TI's head of sales. The effort paid off: As the industry rebounded, TI gained market share for two straight years. Even as its biggest customer, Nokia Corp., has seen its share slide, TI has picked up business from ground-gainers such as LG Electronics and Samsung Electronics.

Problem is, the torrid growth of the mobile-phone market is drawing many rivals. Ericsson (ERICY), NEC (NIPNY), Broadcom, (BRCM) and Freescale Semiconductor (FSL), Motorola's chip division that was spun off in July, all are working on new chips for high-speed wireless communications. Intel is expected to make another run at the market, despite a stumble in its initial effort last year. The most fearsome rival is Qualcomm, which has close ties with red-hot phonemaker Samsung and a head start in the intellectual property for what is known as third-generation, or 3G, wireless technology. "We have a significant lead," says Qualcomm President Anthony S. Thornley.

3G'S TWO TITANS?

No question, TI and Qualcomm are on a collision course. TI dominates in the world's most popular wireless standard today, GSM, while Qualcomm is the top player in the second-most popular, CDMA. As the wireless world moves to 3G, the two companies will lay claim to the same turf. Sales of 3G phones are expected to hit 311 million in 2008, up from 150 million this year. Qualcomm believes it can grab 50% of the market for what's expected to be the most popular 3G technology, W-CDMA. Templeton says TI should be able to take as much share in W-CDMA as it has in GSM, or nearly 40%.

Qualcomm has a slight edge. That's primarily because the 3G standards are closely related to the CDMA technology it has mastered. Still, TI has a broader customer base, a tight relationship with market-leader Nokia, and a proven ability to integrate phone chips with other capabilities. Analysts figure the two giants will end up dominating the 3G market, with Qualcomm having a somewhat greater share. "It's going to be tough for other companies to stay with those two," says Gartner Inc. (IT) analyst Stan Bruederle.

However that battle plays out, Templeton believes other digital consumer devices could be as important for TI's growth as cell phones. One promising product: digital light-processing (DLP) chips. Designed for high-end digital projectors used in movie theaters, TI now is making them the hottest thing in big-screen TVs. Their low cost allows manufacturers to undercut the cost of plasma and liquid-crystal display TVs significantly. According to researcher iSuppli, sales of TVs that use DLPs will more than triple this year to 748,000, and hit 2.3 million in 2007. Meantime, as Templeton points out, the technology Intel is betting on in TVs, liquid-crystal-on-silicon (LCOS), is still on the drawing board.

Investors likely will continue to worry about the prospects for TI and the rest of the chip industry. Still, Templeton has the company positioned smack in the middle of some of the most promising trends in tech. His wager on convergence looks like a pretty good bet.